Does Earnings Management Affect Banks’ Cost of Funding? An Empirical Investigation Across an European Sample

Loan loss provisions which are the main components, by which managers handle earnings, are used discretionally to smooth earnings, manage capital requirements and increase the stock market valuation. However managers’ discretionary behavior might have a negative effect, since hidden risks can alter the risk profile of a bank. In this paper, we investigate whether such a discretionary component of provisioning has an impact on the cost of funding. We use panel data regression on a sample of European banks, during the period 2005–2013. Our finding suggests that the discretionary use of provisioning affects the cost of funding, due to the increase of the overall risk to the bank.